How much do you know about how to evaluate the performance of your investment portfolio?
If the alphabet soup of key investing terms has you overwhelmed, you’re not alone, says San Francisco financial advisor Daniella Rand.
Rand’s high net worth clients trust her for incisive, expert advice, and there’s no reason you shouldn’t expect the same out of your financial advisor. But that’s not to say there’s no value in gaining a basic understanding of the most common performance-related terms.
In the spirit of public knowledge, let’s review seven common concepts that you’ll need to understand to evaluate the performance of your investment portfolio and index funds.
1. Rate of Return
Investopedia defines “rate of return” as “the net gain or loss on an investment over a specified time period, expressed as a percentage of the investment’s initial cost.”
Rate of return consists of any income received on the investment itself (such as dividend payments) and any capital gains on the sale of the investment. Prior to its sale, the rate of return on an instrument is considered “unrealized.”
Yield is the income produced by an investment as a percentage of the investment’s total value. For instance, a stock with a market price of $100 per share at the most recent close and an annual dividend of $3 per share yields 3% on an annualized basis. If the value of that same stock drops to $50 per share and the dividend remains the same, the yield is 6% on an annualized basis.
3. After-Tax Return
After-tax return represents the net return on investment after accounting for applicable taxes on capital gains, interest income, and the like. Taxes can significantly reduce the net rate of return on investments held in taxable accounts; consult a tax professional and your financial advisor for advice about minimizing tax exposure.
4. Real-Dollar Return
Real-dollar return represents the net return on investment after accounting for inflation. Over time, inflation may erode the value of your portfolio; for instance, $500,000 in 1980 dollars was worth about $1.5 million in 2018 dollars.
5. Short Term Capital Gain/Loss
For the purposes of computing capital gains taxes, “short term” describes any holding period under one year. The duration of the holding period matters because short term capital gains are typically taxed at a higher rate than long term capital gains.
6. Long Term Capital Gain/Loss
Long term capital gains and losses apply to investments held for periods longer than one year. Speak with your financial advisor and tax professional about tailoring an investment strategy that minimizes your capital gains tax exposure.
7. Year Over Year
“Year over year” describes an apples-to-apples data comparison pitting data from one year against data from another. This metric is useful for evaluating relative investment performance during two discrete periods of time.
These seven investing concepts are relatively easy for laypeople to understand. For more complicated terms that require more than a few sentences to explain, you’ll want to turn to the experts. Don’t be afraid to push prospective financial advisors to demonstrate their knowledge of the higher-order forces, principles, and theories that influence the financial markets and inform their work. That’s what they’re paid to do, after all.